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The Triple Tax Benefits of HSAs

Last Updated
April 27, 2022
Young girl and mother at medical checkup

How HSAs Can Help With Healthcare and Tax Planning

Health savings accounts (HSAs) offer a flexible way to save for healthcare expenses, both while you’re working and during retirement. Unlike flexible savings accounts (FSAs), your HSA is not tied to your employer, which means you can take the funds with you when you leave employment. You also have the flexibility to change your contribution amount at any time, and any unused funds automatically roll over to the next year.

However, the most valuable benefit of contributing to an HSA is the tax savings potential they provide. The following three tax advantages provided by an HSA make it one of the ultimate tax saving accounts most of us have access to.

Tax-free contributions

Similar to contributions to a traditional 401(k) or IRA, contributions to HSAs are made with pre-tax dollars, which reduces your taxable income in the year contributions are made.

If you contribute to an HSA through your employer, contributions are deducted from your paycheck before taxes, both payroll and income taxes. If you don’t have access to an employer-sponsored HSA, you can still contribute to an HSA and claim any contributions as tax deductions when you file your taxes.

Due to the tax-advantaged status of HSA contributions, the IRS limits the amount you can contribute within a given year. For 2022, the maximum HSA contribution is $3,650 for individuals and $7,300 for families. Those who have reached age 55 are eligible to contribute an additional $1,000 per year.

Tax-free growth

Once contributed, HSA funds grow tax-free in the account. This is a significant benefit over a regular savings account, in which earnings are considered taxable income. In an HSA, both the contributions to the account and the earnings accumulated within the account can grow tax-free.

Also, HSAs never expire and do not have required minimum distributions (RMDs) like other retirement savings accounts.

Tax-free withdrawals

Unlike pre-tax contributions made to traditional 401(k)s and IRAs, which are taxed upon withdrawal, distributions from HSAs are completely tax-free as long as they are used to pay for qualified medical expenses.

If you have not yet reached age 65 and use HSA funds to pay for non-medical expenses, the distribution will be subject to taxes as well as an additional 20% penalty. However, once you reach age 65, you may use HSA funds for any reason. If used to pay for non-medical expenses, withdrawals after age 65 are taxed but not subject to the additional 20% penalty. Because of this perk, many investors use HSAs as another type of retirement savings vehicle.

It’s important to note that you can no longer contribute to an HSA once you begin receiving Medicare benefits. In addition, residents of New Jersey and California may be subject to state income tax on HSA contributions and earnings.

In order to contribute to an HSA, you must be enrolled in a high-deductible health plan (HDHP). This type of plan is typically best suited to younger, healthier people who don’t have many current medical expenses. If you have a chronic illness or visit the doctor frequently, an HDHP may not be the best fit for your situation.

Your wealth manager can help you evaluate the pros and cons of different health plan options and HSA savings strategies in order to make an informed decision. For more information, schedule a call with a member of our team.

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This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.

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